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Sunday, October 9, 2016

The Political Problems with Helicopter Money

One of the problems with “helicopter money” is that the proponents of the concept give very sketchy and differing descriptions of what it actually is. From my personal perspective, another difficulty with discussing the idea is that I disagree with the politics. Depending on how “helicopter money” is conceived, either it is an insult to the intelligence of the electorate, or it is premised on the idea that politicians are structurally biased towards favouring deflationary policies – a stance for which there is very little evidence.(This article is an unedited draft that will be published in my next book: Abolish Money (From Economics)! There is only a small amount of material to be added, at which point I will be doing another pass of editing. This has taken longer than expected, as the book is now at 50,000 words, while my initial target was 20,000 (ouch). Some material will be moved for publication later. Although it may be possible to publish in early November, that may put too tight a deadline for myself and my advance readers and editor. Since I want to avoid publishing in December, the most likely target is a publication date in early January.)

What is “Helicopter Money”?

I will discuss the technical definitions of “helicopter money,” elsewhere. I will instead offer high-level summaries from political economy perspective.

Firstly, the origin of the term came from Milton Friedman, who needed a mechanism to explain how the central bank controls an “exogenous” money supply. In order to create money, central bankers allegedly fly around in helicopters and drop money onto citizens’ heads. Since the money is not exogenous (as I discuss in “Primer: Endogenous Versus Exogenous Money”), this whole line of argument can be easily dismissed. In summary, if you do not believe stupid things about “money,” you will not believe stupid things about central bank operations (central bankers hopping into helicopters with bags of cash).

Otherwise, there are two flavours of “helicopter money” from a political economy perspective; implementation details can vary between proponents.

Overt Monetary Financing. The central bank “finances” a fiscal stimulus that is controlled by the spending arm of the government (the Treasury or Ministry of Finance).

Central Bank-Directed Stimulus. The central bank directly implements transfer payments – which is a form of fiscal policy – based on its views of the economic cycle, independent of what the Treasury wishes.

I will discuss these policy options separately, after a digression on the euro area.

The Euro Area Exception

The situation in the euro area is an exception to my discussion here. There is no centralised pan-Euro Treasury of any significant size, and so the only way of running hefty counter-cyclical fiscal policy might require financing by the European Central Bank.

Many of the proponents of “helicopter money” are European, and are quick to offer the situation in the euro area as an example of the usefulness of helicopter money. Those of us who are non-European have a wider perspective, and realise that we cannot generalise the dysfunctional euro area institutions to other regions.

Finally, I will note my cynicism even concerning the euro area. The European Central Bank was part of “the Troika” which levelled the economies of the European periphery. The ECB is politically unaccountable, and part of the problem of governance on the euro area. Giving an out-of-control, unaccountable organisation with a horrific decision-making track record more power on the theory that the next episode will turn out better seems to be questionable logic.

Overt Monetary Financing

Overt Monetary Financing is a piece of jargon that just says that the central bank will finance Treasury spending. The alleged advantage is that this lowers the probability of Treasury default to 0%, and so the Treasury can spend without worrying about “fiscal sustainability.”

Unfortunately, as I discussed in Understanding Government Finance, the probability of default was 0% to begin with. There is no advantage to “Overt Monetary Financing” versus “Standard Government Finance.”

The rejoinder is that the electorate is allegedly stupid, and they do not understand that governments with currency sovereignty cannot be forced to involuntarily default. My response is that the people backing “helicopter money” are implicitly peddling myths about “financial constraints,” and are part of the problem, and not part of the solution.

In any event, the issue is that the Treasury has to want to undertake the extra spending that is “financed with money.” Since politicians appear to understand government finance better than many economists do, they are likely to be skeptical about such schemes. Instead, they will only spend what they wanted to spend in the first place, and they know that they can achieve such spending using standard government financing techniques.

This leads into the next section, where the central bank takes control of spending.

Central Bank-Led Fiscal Policy

The central bank can lead the horse to water, but cannot force it to drink. Therefore, there are arguments that the central bank should engage in fiscal policy: transferring money to citizens as part of economic stabilisation policy.

The economic justification is the dreaded “zero bound”: with the policy rate stuck at 0%, the central bank needs to stimulate the economy in order to hit its inflation target. If the economy comes roaring back, the policy rate could be raised, and helicopter money suspended.

Unfortunately, there is no clean way for the central bank to implement such a policy in an independent fashion. The usual way that helicopter money is supposed to work is via the central bank sending “money” to “all” citizens. If the central bank wanted to this itself, it would need to create a bureaucracy to monitor the eligibility of individuals for the programme, which would require large, intrusive surveillance. This is solely needed so that this new organisation can mail out small cheques once per decade (at most).

If a Canadian prairie populist party somehow swept into power, and I was somehow associated with such a government, the very first thing I would do is to move to shut down such a programme on the basis that it is a screaming example of governmental stupidity and waste. One also needs to keep in mind that I am a Keynesian.

Realistically speaking, the programme would need to piggyback on another central government institution that has regular cash transactions with the population. In Canada (and probably most other developed countries), the only infrastructure that meets that definition is the payroll tax withholding system. Tax rates in that system can be tweaked relatively quickly, but doing so does create compliance problems for small businesses if it is done at an irregular time. The reality is that central bank will not be able to adjust those payroll deduction settings in any more efficient manner than the elected government.

The reliance on an existing distribution framework means that the central bank has no reaction time advantage over the Treasury (which is an alleged advantage of policy rate changes). Furthermore, the slowness of the reaction of fiscal policy is greatly exaggerated. Developed countries reacted very rapidly with fiscal stimulus during the Financial Crisis, including the (fiscally conservative) Canadian Conservative Party. Additionally, even if there are implementation lags, expectations matter (to quote our New Keynesian friends). It is very easy to structure tax policies to reward behaviour now, even if the cash reward is delayed (for example, investment/depreciation credits).

We are then stuck with a position that should raise eyebrows: we cannot trust elected governments to enact discretionary policy because they have a structural tendency to keep fiscal policy too tight. The only sensible reaction is: no sale.

Developed country central banks were given independence to pursue inflation targeting mandates, as mainstream economists had intoned for decades that politicians had a structural tendency to favour inflationary policies. Moreover, there is a reason why people listened to them then: they had a lot of evidence on their side. As the chart above shows, inflation control was not exactly a strong point of the post-war “Old Keynesian” policy mix.

The closest that there comes to evidence in favour of the “helicopter money” view was the flirtation with austerity during the post-crisis era. Of course, we cannot point to the disastrous austerity policies in the euro area periphery, since the European Central Bank was the key enforcer in ramming austerity policies down the throats of elected politicians. If we look at the milder austerity policies in the English-speaking world, one could say that they were wrong-headed. However, that was just politics: worries about government debt were used to justify policies that would have been otherwise unpopular. Conservative politicians were doing exactly what their supporters wanted them to do; and the economic environment was quite favourable for those backers (a decreased wage share of national income pushed up the profit share). In any event, there is little reason to believe that such politicians would continue to support austerity if there was a downturn that was disadvantageous to their backers.

Advice to Central Bankers: Life Ain’t Fair

From a central banker perspective, the inflation-targeting framework is somewhat unfair. They have no effective mechanism to raise inflation if the policy rate hits the zero bound. (I am ignoring what mainstream economists the “neo-Fisherian debate”: raising interest rates raises inflation. Central bankers do not believe that viewpoint.) As I tell my kids: life ain’t fair.

In the private sector, employees are commonly given contradictory orders by their bosses. It is up to the employee to figure out what their employer really wants, and deliver that. Central bankers have to accept that politicians have a number of economic objectives, and a symmetric adherence to an inflation target is not politicians’ highest priority.

In the English-speaking world, what we have seen since the crisis is small, persistent errors concerning hitting the inflation target: inflation was closer to 1% than 2% (rounding off the actual numbers). Although that is technically missing central banks’ inflation targets, the political reality is that nobody cares about that.

Obviously, some politicians and voters did not like some of the side effects/causes of low inflation, such as tepid job growth and the squeeze of workers’ share of national income. However, those “side effects” are what they are worried about, not the inflation rate. Nobody sensible cares whether the inflation rate is 1% or 2%, if there are no other changes to the economy. However, the deviations are not symmetric; people would start to become unhappy if inflation heads north of 3-4%, even if no other economic variables are unchanged. The only people that care whether inflation is 1% instead of 2% are New Keynesian economists with a fixation on the “natural rate of interest.”

Returning to central bankers – no politician is going to hold them to account for small deviations below the inflation target, so it does not matter if they are missing on that part of their mandate. As a result, there is no need to open the constitutional can of worms that delegating spending power to an unelected body represents.

Concluding Remarks

It is difficult to see what political economy objective helicopter money achieves. Meanwhile, the belief that central banks need to have the power to enact fiscal policy because elected officials are structurally averse to deficit spending has to be one of the most evidence-free political beliefs that I have come across in my lifetime.

7 comments:

Brian, Under the heading "overt money finance" you claim "there is no advantage to “Overt Monetary Financing” versus “Standard Government Finance.” because the chance of default in both cases is zero.

However the chance of default is not the only difference between the two: there's also the fact that first involves printing money while the second involves printing debt on which interest is paid. Since the object of the exercise is stimulus, and since government borrowing as such has the opposite effect (i.e. it's deflationary) strikes me that OMF is better: what's the point of doing something deflationary when the object of the exercise is the opposite? Completely mad.

Of course I’m aware that if you tell politicians and the academics who worry about the debt, e.g. Rogoff and Reinhart, that debt problems can be removed by simply printing money, a proportion of them will then start chanting “inflation”. However, the fact is that dummie Rogoff and dummie Reinhart haven’t actually kicked up anywhere near the fuss about helicopter money or its possible inflationary consequences, as compared to the fuss they kick up about debt. Indeed, I haven’t actually come across their saying anything AT ALL about the possible inflationary consequences of helicopter money.

Your final paragraph claims “…the belief that central banks need to have the power to enact fiscal policy because elected officials are structurally averse to deficit spending has to be one of the most evidence-free political beliefs that I have come across in my lifetime.”

Personally I find myself buried by an absolute avalanche of evidence. There is so much that I don’t know where to start. Presumably you’ve heard about Kenneth Rogoff and Carmen Reinhart’s never ending campaign against government debt? Aren’t you aware that about 95% of politicians on both sides the Atlantic have fallen for this nonsense and are worried about “the debt”. Haven’t you heard about Simon Wren-Lewis’s correct observation that the media has also fallen for the latter debt nonsense? He calls it “macro-media”.

As it happens, SW-L did a post today on that topic and I left a comment after it.

The interest cost is the same thing (within spread issues). If you create excess reserves, the interest rate paid on those reserves will equal the t-bill rate, and so the net cost to the consolidated government is the same. If one argues that it is different that the central bank is paying it, and not the Treasury, you are insinuating that politicians are unable to read simulations that will show them there is no net impact (since central bank dividends are reduced).

Sure, you can raise reserve requirements to convert excess reserves to required reserves, but that could be done in the absence of helicopter money. And that is a bad idea, as I discussed elsewhere.

As for the R&R campaign against debt, the only way to defeat stupidity is by being smart. Lying to the electorate about helicopter money is not a great way to defuse lies about government debt. Some people might disagree with the usefulness of white lies, but I am a prairie populist, and in my view, nothing good ever came out of lying to the citizenry. They will figure it out.

Who said anything about "excess reserves"? I certainly don't advocate the issue of so much base money (aka reserves) that the state then has to thwart the excess demand that would otherwise arise by raising interest rates or paying interest on reserves. I.e. I go along with the policy advocated by Milton Friedman and Warren Mosler: issue enough base money to keep the economy at full employment, while not paying any interest on state liabilities.

Getting back to your original article, You say “no politician is going to hold them (central banks) to account for small deviations below the inflation target..”. True enough. But that ignores a much more important point, namely what was the shortfall in GDP attributable to conventional policies after the 2007/8 crisis? Looks like the shortfall was in the 5% - 10% range which is serious. No one knows how much of that problem helicopter money would have solved, but it could hardly have done worse than pathetically slow recovery we've actually had.

This is the problem with "helicopter money": everyone projects their own meaning onto the term.

I am using what I believe is a standard definition of HM: the central bank is given *new powers*, that to conduct fiscal policy.

You (and Mosler, etc.) are advocating *taking away* central bank powers - the ability to set interest rates; they are locked at zero by legislative fiat. Needless to say, that is a completely different proposal than I am discussing here, and so my comments would not apply to your proposals.

My comment about "lying" was too broad, what I should have written was "white lie." But once again, that is not applicable to what you are suggesting.

To understand why spending currency is not a solution to any modern economic problem, first consolidate the central bank and federal Treasury functions into a Sovereign, then write the following identity for the Sovereign balance sheet position:

Traditional high powered money would be created by a debit (increase) to financial assets F and a credit (increase) to reserves R.

Balanced budget debt would be created by a debit (increase) to either non-financial assets K or financial assets F and a credit (increase) to Treasury securities B.

Helicopter money would be spent via a debit (decrease) to net worth and a credit (increase) to currency. The net worth of the central bank or of the consolidated government would decrease for HM.

Helicopter debt would be spent via a debit (decrease) to net worth and a credit (increase) to Treasury securities. The net worth of the government would decrease for helicopter debt.

Inflationary and deflationary impacts depend on the prevailing conditions in the economy and the size of the stimulus, not on whether the government issues helicopter money or helicopter debt! During a deflation the consolidated government should transfer money to those who will spend to generate inflation, and should pay interest on its debt to those who want more savings, because people who produce do so in the expectation of profit and growth of savings. During excessive inflation the consolidated government must either reduce its deficit spending or jack up short term interest rates to such a high level that a recession is induced via the leveraged financial intermediaries. This would wipe out some credit formation in a bankruptcy event and force the more aggressive financial intermediaries into bankruptcy based on the concept of "interest rate risk."

Regarding the identity for a consolidated central bank and Treasury, the Federal Reserve says the amount of currency in circulation depends on the public demand for currency:

https://www.federalreserve.gov/paymentsystems/coin_about.htm

Federal Reserve notes are liabilities on the Federal Reserve's balance sheet. The asset counterpart to these liabilities is typically U.S. Treasury securities, mortgage-backed securities, and other assets. The Federal Reserve receives interest earnings from the assets that collateralize Federal Reserve notes. The income of the Federal Reserve System is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. After it pays its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury. About 95 percent of the Reserve Banks’ net earnings have been paid into the Treasury since the Federal Reserve System began operations in 1914. When a depository institution orders and deposits currency from its servicing Reserve Bank, the institution’s account balance is adjusted accordingly.

Coin held by the Reserve Banks is an asset on its balance sheet and the Reserve Banks buy coin from the Mint at face value. When a depository institution orders and deposits coin from its servicing Reserve Bank, the institution's account balance is adjusted accordingly.

In a growth economy the federal government sells Treasuries in the first instance to cover the deficit. This permits the central bank to purchase Treasuries from nonbanks if the public withdraws currency from the aggregate bank. Thus the public decides whether it wants to hold currency or interest bearing government debt.

Helicopter money used to cover a deficit may cause problems for the central bank if this currency is deposited into the aggregate bank and presented to the central bank to purchase more reserves. The central bank would swap out currency liabilities for reserves, however, it would not have assets on its balance sheet to sell to banks or nonbanks to drain the excess reserves.

So the central bank might be forced to depend on the Treasury to issue debt to drain reserves if the deficit is covered initially by printing currency rather than by printing (issuing from thin air) a new Treasury security.

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